An angel investor is a wealthy individual who uses their own money to invest in small businesses. A venture capitalist, on the other hand, is an individual or firm that makes a similar investment using money pooled from other companies, corporations, and pension funds. Venture capitalists do not invest their own money. In many cases, venture capitalists need angel investors to understand businesses with great potential from a very early stage.
Understanding angel investors
The angel investor provides capital to an early-stage start-up in exchange for equity or convertible debt. Some angel investors will also provide mentorship and advice, while others form syndicates and collectively invest in businesses.
Most angel investors are accredited by the Securities Exchange Commission (SEC) provided they meet one of two conditions:
Their annual income was at least $200,000 for the past two years. This increases to $300,000 if the individual files taxes with a spouse.
They have a minimum net worth of $1 million, excluding the value of their primary residence.
When Amazon was a startup, for example, Jeff Bezos received $300,000 from his parents and a further $1 million from twenty wealthy investors who contributed $50,000 each.
Note that angel investors serve as the bridge between the initial financing needs of a startup and more significant capital requirements as it grows. They are focused on helping the entrepreneur build their business and, at least initially, are less concerned with making a profit.
Angel investor advantages
Angel investors tend to be less risk-averse than traditional financial institutions. In most cases, they do not expect to be paid back if the venture they are financing fails.
Entrepreneurs also benefit from the wealth of industry knowledge and experience that many such investors bring to the table.
Understanding venture capitalists
Venture capitalists are employees of venture capital firms that invest using money from other companies, large corporations, and pension funds.
While angel investors are a critical early source of funding, venture capitalists provide funding for more established startups to help them transition through various growth stages into mergers, acquisitions, or IPOs.
Venture capitalist investment also tends to be more significant, with a single investment typically in the range of $3-5 million and lasting around a decade. In return, venture capitalists expect to be involved in operations and may request a seat on the board of directors.
Venture capital funding is ideal for businesses that want to scale quickly. Like angel investment, there is generally no expectation that the money is paid back if the business fails.
Some venture capitalists are also well connected. In other words, they have a vast network of professional contacts that the startup can access to secure additional funding or recruit experienced talent.
Key takeaways:
An angel investor is a wealthy, accredited individual who uses their own money to invest in small businesses. A venture capitalist is an individual or firm that invests the money of other companies, corporations, and pension funds.
Angel investors provide capital to early-stage start-ups in exchange for equity or convertible debt. They may also provide mentorship and play a critical role in sustaining the operations of early-stage startups.
Venture capitalists invest significant sums of money over longer timeframes to help startups undertake mergers, acquisitions, or IPOs. In exchange, many venture capital firms request a seat on the startup’s board of directors.
The circle of competence describes a person’s natural competence in an area that matches their skills and abilities. Beyond this imaginary circle are skills and abilities that a person is naturally less competent at. The concept was popularised by Warren Buffett, who argued that investors should only invest in companies they know and understand. However, the circle of competence applies to any topic and indeed any individual.
Economic or market moats represent the long-term business defensibility. Or how long a business can retain its competitive advantage in the marketplace over the years. Warren Buffet who popularized the term “moat” referred to it as a share of mind, opposite to market share, as such it is the characteristic that all valuable brands have.
The Buffet Indicator is a measure of the total value of all publicly-traded stocks in a country divided by that country’s GDP. It’s a measure and ratio to evaluate whether a market is undervalued or overvalued. It’s one of Warren Buffet’s favorite measures as a warning that financial markets might be overvalued and riskier.
Venture capital is a form of investing skewed toward high-risk bets, that are likely to fail. Therefore venture capitalists look for higher returns. Indeed, venture capital is based on the power law, or the law for which a small number of bets will pay off big time for the larger numbers of low-return or investments that will go to zero. That is the whole premise of venture capital.
Foreign direct investment occurs when an individual or business purchases an interest of 10% or more in a company that operates in a different country. According to the International Monetary Fund (IMF), this percentage implies that the investor can influence or participate in the management of an enterprise. When the interest is less than 10%, on the other hand, the IMF simply defines it as a security that is part of a stock portfolio. Foreign direct investment (FDI), therefore, involves the purchase of an interest in a company by an entity that is located in another country.
Micro-investing is the process of investing small amounts of money regularly. The process of micro-investing involves small and sometimes irregular investments where the individual can set up recurring payments or invest a lump sum as cash becomes available.
Meme stocks are securities that go viral online and attract the attention of the younger generation of retail investors. Meme investing, therefore, is a bottom-up, community-driven approach to investing that positions itself as the antonym to Wall Street investing. Also, meme investing often looks at attractive opportunities with lower liquidity that might be easier to overtake, thus enabling wide speculation, as “meme investors” often look for disproportionate short-term returns.
Retail investing is the act of non-professional investors buying and selling securities for their own purposes. Retail investing has become popular with the rise of zero commissions digital platforms enabling anyone with small portfolio to trade.
Accredited investors are individuals or entities deemed sophisticated enough to purchase securities that are not bound by the laws that protect normal investors. These may encompass venture capital, angel investments, private equity funds, hedge funds, real estate investment funds, and specialty investment funds such as those related to cryptocurrency. Accredited investors, therefore, are individuals or entities permitted to invest in securities that are complex, opaque, loosely regulated, or otherwise unregistered with a financial authority.
Startup valuation describes a suite of methods used to value companies with little or no revenue. Therefore, startup valuation is the process of determining what a startup is worth. This value clarifies the company’s capacity to meet customer and investor expectations, achieve stated milestones, and use the new capital to grow.
Profit is the total income that a company generates from its operations. This includes money from sales, investments, and other income sources. In contrast, cash flow is the money that flows in and out of a company. This distinction is critical to understand as a profitable company might be short of cash and have liquidity crises.
Double-entry accounting is the foundation of modern financial accounting. It’s based on the accounting equation, where assets equal liabilities plus equity. That is the fundamental unit to build financial statements (balance sheet, income statement, and cash flow statement). The basic concept of double-entry is that a single transaction, to be recorded, will hit two accounts.
The purpose of the balance sheet is to report how the resources to run the operations of the business were acquired. The Balance Sheet helps to assess the financial risk of a business and the simplest way to describe it is given by the accounting equation (assets = liability + equity).
The income statement, together with the balance sheet and the cash flow statement is among the key financial statements to understand how companies perform at fundamental level. The income statement shows the revenues and costs for a period and whether the company runs at profit or loss (also called P&L statement).
The cash flow statement is the third main financial statement, together with income statement and the balance sheet. It helps to assess the liquidity of an organization by showing the cash balances coming from operations, investing and financing. The cash flow statement can be prepared with two separate methods: direct or indirect.
The capital structure shows how an organization financed its operations. Following the balance sheet structure, usually, assets of an organization can be built either by using equity or liability. Equity usually comprises endowment from shareholders and profit reserves. Where instead, liabilities can comprise either current (short-term debt) or non-current (long-term obligations).
Capital expenditure or capital expense represents the money spent toward things that can be classified as fixed asset, with a longer term value. As such they will be recorded under non-current assets, on the balance sheet, and they will be amortized over the years. The reduced value on the balance sheet is expensed through the profit and loss.
Financial statements help companies assess several aspects of the business, from profitability (income statement) to how assets are sourced (balance sheet), and cash inflows and outflows (cash flow statement). Financial statements are also mandatory to companies for tax purposes. They are also used by managers to assess the performance of the business.
Financial modeling involves the analysis of accounting, finance, and business data to predict future financial performance. Financial modeling is often used in valuation, which consists of estimating the value in dollar terms of a company based on several parameters. Some of the most common financial models comprise discounted cash flows, the M&A model, and the CCA model.
Business valuations involve a formal analysis of the key operational aspects of a business. A business valuation is an analysis used to determine the economic value of a business or company unit. It’s important to note that valuations are one part science and one part art. Analysts use professional judgment to consider the financial performance of a business with respect to local, national, or global economic conditions. They will also consider the total value of assets and liabilities, in addition to patented or proprietary technology.
A financial option is a contract, defined as a derivative drawing its value on a set of underlying variables (perhaps the volatility of the stock underlying the option). It comprises two parties (option writer and option buyer). This contract offers the right of the option holder to purchase the underlying asset at an agreed price.
Gennaro is the creator of FourWeekMBA, which reached about four million business people, comprising C-level executives, investors, analysts, product managers, and aspiring digital entrepreneurs in 2022 alone | He is also Director of Sales for a high-tech scaleup in the AI Industry | In 2012, Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy.
